Much maligned, more misunderstood

The first time public sector banks came into public focus in India was in 1993, when against the background of financial sector reforms, a comprehensive review on the performance of state-owned banks was done by the finance ministry. The outcome of the assessment was pretty grim, even without a number of prudential norms that came up later.

With nearly 50 per cent of the loans being on the verge of nonperforming, a large number of loss-making branches, bloated staff and a culture of captive business that mocked productivity and profitability parameters, PSBs represented all that a country in the reform mode cannot afford. Analysts wrote off the future of these banks saying they wouldn’t stand a chance in a reform environment driven by competition and privatisation.

Partly due to the government and mostly due to the Reserve Bank of India, and to some extent the leadership and management of banks, in the last two decades of reforms, these banks have made a turn around that is quite impressive, though certain legacy issues continue to bother them even now. This could be the reason why PSBs are known more for their woes and problems, and are panned disproportionately with regard to aspects such as asset quality and sloppy lending practices which, incidentally, are an outcome of control parameters rather than performance metrics. An attempt to balance the record with the bright side of the report is made here.

All the 20 PSBs are featured among the world’s top 1000 banks by The Banker , London (except the newly created Bharatiya Mahila Bank and Post Bank of India). In a study conducted in 2012 at BIS based on a sample of 240 banks in 12 Asian economies since the Asian financial crisis of the late 1990s, the summary data of Indian banking as compared to emerging markets is quite good: a ratio of loan loss provisions over total assets standing at 0.50 (0.49/0.55 — the figures in brackets are the average for the whole sample and China respectively); ratio of loan loss reserves over total assets at 1.39 (1.72/1.46); ratio of total capital over risk-weighted assets at 12.76 (11.46/9.51); ratio of non-performing loans over total assets at 2.86 (3.92/4.85); growth rate of bank loans at 21.98 (8.70/20.01); ratio of bank loans over total assets at 50.73 (60.61/52.12) and the ratio of earnings before tax and provisions over total assets at 1.83 (1.18/1.57).

With regard to efficiency as measured by net interest margin and related indicators such as non-interest income, overhead costs, profitability and so on, South Asia (which is largely represented by India) is on par with the average of high income countries, and higher than the average of East and South East Asia, according to the World Bank’s Global Financial Development Report2013 which devoted a whole discussion on the theme, ‘Rethinking the Role of State in Finance’.

On an important prudential measure such as provisioning, a recent BIS paper noted that “there is evidence of countercyclical loan loss provisioning by banks throughout emerging Asia, most strikingly so in India… In India, countercyclical provisioning originates not only from income smoothing behaviour but also from additional loan loss provisions during economic upswings”. This is a practice widely appreciated and for which the central bank is duly credited. In the 1990s and 2000s, about there were about a hundred episodes of banking crisis across the emerging world but India managed to get by without one.

New evidence suggests that PSB lending is less procyclical; in several instances it is counter-cyclical and that helps businesses overcome the impact of a crisis. Bank credit to the non-financial sector in India as a share of total credit to the sector, which is mostly contributed by PSBs, is at a high of 92 per cent compared to 75 per cent in China and 67 per cent in Korea. This shows the importance of bank intermediation in India. Total credit to the non-financial private sector between the years 2004 and 2013 in India rose by nearly 21 percentage points, from 38 per cent to 59 per cent, though a robust real economy could have made it grow much faster. The most recent annual report of the BIS placed India in an upswing in the current financial cycle.

The downside that seems to be daunting the sector now is the slowdown of credit growth. Thist is an extension of the deteriorating credit conditions prevalent across the entire emerging world and the surge in NPAs which is the outcome of an economy that continues to face a myriad structural, control and governance issues. Surely these are major challenges but PSBs could be enabled and empowered with the right blend of responsibility, performance and accountability to manage the changing tides in economy and finance.

In the gloom and doom that the US banking sector experienced in the aftermath of the subprime crisis, it was one lone government-owned North Dakota bank that shone like a star for its support to the business and community in a time of crisis. There was a chorus in the US at that time to create more banks like it that would benefit business and people.

The global financial crisis has also brought the glory back to the role of the state in finance, to some extent. With much of the growth now shifting to an emerging world where the state continues to play a larger role, India could seize this opportunity to create a unique brand of public sector banking that stands out as an effective developmental model with the right blend of public purpose and market framework.

Markets globally loved India’s Bank Stock Index (Bank Nifty/Bankex) that has a fair share of PSBs as index constituents. This validates the premise that what matters both to the society and markets is the contribution and performance of institutions rather than issues of ownership.

The writer was the chief economist of Indian Banks Association. The views are personal

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